Dear Batbeer2, I just saw your post.... I'm trying to understand your point, but am having difficulty. How is this different from holding a long-term government bond that pays 15% interest? I could choose to sell the bond at a premium and use the proceeds to purchase some other investment that I thought had a better rate of return.

A $1000 government bond yielding 15% will get you $150 per annum. If at some point someone offers you more than $1000 you can sell it at a profit (plus the interest you collected). That bond would be worth less since it is now closer to maturity. The present value of future interest is smaller. The guy buying must be more foolish than you.

1000 dollars of a stock yielding 15% and a 30% sustainable ROE will get you:
150 of earnings this year and
150 + 30% of 150 next year = 195 and
195 + 30% of 195 the year after.

Companies like that do exist.

You can see that 500 worth of a good stock will get you a much greater return in the fifth year than 1000 of bonds. In ten years, assuming the business continues to perform, you can sell it at a 15% yield (someone precisely as foolish as yourself) but at a huge profit.

Once you've found a stock like that, you will have noticed this effect and you will want to hang on to it under most circumstances including times when some fools are offering to buy it at a 3% yield (p/e of 33).

Thank you for your response. I think I understand your point.The hard part, though, is being certain that the company will compound well and consistently far into the future.

If the market thought so too, it should value such a stock at a very high PE.This is clearly true for classic growth stocks, but I guess should be true for stocks with lower rates of growth, but where that growth is assured.

And, for such a stock, the price at which the stock was purchased matters much less (which is Science of Hitting's point).

The interesting thing is that historically, you've historically focused on stocks that are beaten down. While that makes sense for short term investing -- and you've been quite successful as of late pointing out these stocks -- shouldn't you also be focusing on stocks that have more "normal" valuations, but whose ability to compound in the future is under appreciated by the market?

I went back and read some of your old articles and I have a question....I was reading about the two classes of stock on Viacom...when you do a chart comparing the premium from one to the other what source do you use?I would love to be able to compare all sorts of stocks to each other the way you did and not just on a regular compare chart

>> Shouldn't you also be focusing on stocks that have more "normal" valuations, but whose ability to compound in the future is under appreciated by the market?

I can see how you get the impression that I say one thing and do another. NTE, QUAD, AHC etc. were obviously beaten down. What you don't see is that I pass on stuff like Hanfeng, Natuzzi, CRC, PostNL and lierally hundreds of others before I settle on QUAD.

Whereas I'm able to find dozens of beaten down stocks within minutes, I can spend weeks finding out if any of them happens to have significant franchise value. The reason I buy QUAD is because I think that business, unlike PostNL, Natuzzi, CRC, GENC etc. etc. etc, can compound value at a decent rate over the long term.

So while it is true that I usually buy beaten down stocks, it is also true that I spend more than 90% of my time thinking about the competitive advantages of the business.

As you are aware, I sometimes analyse high quality fully-priced stocks. Analysing something like BLL helps me understand the competitive advantages of a beaten down stock like QUAD. In essence, they both churn out huge volumes of stuff that isn't worth transporting over long distances.

I'll grant you FNMAJ and BBRY are of a different breed. I have personal reasons for owning things like that at this point in time. Not to worry, I expect to be back to my usual MO before the year is over.

I have really enjoyed reading your past articles and posts, so I hope you don't find the following questions too argumentative, but I just had to ask:

1. If QUAD is an example of an undervalued company that can compound value at a satisfactory rate over the long term, shouldn't your fair value estimate be much higher than the $40 per share you estimated on 3/16/2012?

2. If you can really identify those stocks that are able to compound value over time, then the price that you pay is of comparatively little importance, so why the emphasis on beaten down shares? That would seem to be needlessly limiting, especially in today's market where you've commented that you are having a harder time finding equity investments to your liking.

3. From your past portfolios and comments, I get the feeling that you do not typically hold your equity investments for extended periods (e.g. > 5 years). However, like in the example you provided, if you really knew a company's value would compound consistently and well, for an extended period of time, shouldn't you be holding your positions longer?

2) No. When I buy a beaten down stock that I think will compound value at a decent rate, I have to be wrong twice to lose money. I like the odds. Incidentally, about 75% of my picks work out well. I guess, I should stick with this approach given that my track record indicates I'm wrong half the time.

3) Yes. I have been trading too much. Then again, I've been picking stocks since 07/08. I've learnt a few things since. Holding my stocks for > 5 years would mean I would now still be holding my very first portfolio.

I like to think the turnover was caused by an increasingly high hurdle rate. DJCO is the only one I've found so far that has shown it can compound value at a rate I now consider satisfactory. WPO met those criteria a couple of years ago but fails them now. Not because WPO is a worse company (it is not) but because my criteria have evolved.

In my opinion, SPLS, QUAD, BRS, CRMT and some others can also compound value over time.

BUT

As far as I can tell, they will not compound value at the rate I require. That is the main reason I've sold some of them after they ran up.

In short, I like to think I'm a buy-and-hold investor. I just haven't found enough stocks that meet my criteria. Those criteria are higher now than they were a couple of years ago. Till I find a handfull of stocks that do meet my criteria, I'll muddle along with the contrarian picks that have at least some growth value.

P.S.
We're talking about me and not about stocks. Maybe this forum is not the best place for that. You know where to reach me.

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